Today’s half year update from Aviva (LSE: AV) is encouraging and shows that the company is moving from strength to strength. In fact, Aviva has stated that the integration of Friends Life, which was acquired for £5.6bn, is progressing ahead of its already optimistic schedule. This is very positive news for Aviva’s investors, since the challenge of joining two major businesses within the same sector could have been a significant one and had the potential to hurt financial performance and investor sentiment.
However, with Aviva reporting that it is confident of meeting the £225m target of synergies, the merger seems to have been a wise move. Not only does it create a more efficient overall business, Aviva also has the potential to dominate the life insurance market, which should provide it with improved margins and growth over the medium to long term.
Furthermore, over a million customers of Friends Life are switching from funds run by AXA (to whom Friends Life outsourced the management of part of its funds) to funds run by Aviva, with over £24bn expected to be transferred in total. And, with Aviva reporting a rise in operating profit from £1.07bn in the first half of 2014 to £1.17bn in the first half of the current year, it appears to be making excellent progress and this has allowed it to increase dividends per share by 15%.
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As a consequence, Aviva now yields 3.9% and, looking ahead to next year, is forecast to deliver a significant increase in dividends so that it yields a very enticing 4.6% in 2016. Furthermore, with Aviva trading on a price to earnings (P/E) ratio of just 11.3, there is considerable scope for an upward rerating over the medium to long term.
Of course, there are a number of other insurance companies that also have a bright future and offer excellent dividend prospects. For example, Esure (LSE: ESUR) currently yields 5.4% and, with dividends set to rise by 5.6% next year, its income prospects appear to be more appealing than those of Aviva – in the short to medium term, at least.
However, Esure’s earnings growth prospects are somewhat disappointing. For example, in the current year it is expected to post a fall in its bottom line of 3%, while next year is due to deliver a rise in net profit of just 4%. Both of these figures compare very unfavourably with those of Aviva, which is forecast to see a decline of 2% this year and rebound with 12% growth next year. And, with Esure trading at a premium to Aviva on a P/E ratio of 13.8, the share price performance of Aviva is likely to surpass that of Esure.
Moreover, Aviva’s dividend represents a far lower proportion of profit than Esure’s, with the former having a payout ratio of 39% versus 75% for the latter. So, while Aviva’s yield may be lower than Esure’s at the present time, its combination of faster-growing profitability and a greater scope to pay out a higher proportion of profit as a dividend mean that, beyond 2016, it is set to become the better income play.
